Corporate Corruption Matters for Public Governance: Empirical Evidence and Implications for AntiCorr

1
Corporate Corruption Matters for Public
Governance Empirical Evidence and Implications
for Anti-Corruption Strategies

• Daniel Kaufmann, World Bank Institute
• www.worldbank.org/wbi/governance
• Keynote Presentation at the 3rd ICAC Symposium on
  Anti-Corruption,
  
• Hong Kong, May 9th, 2006
• "If you cannot measure it, you cannot improve
  it."
  
• -- Lord Kelvin

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Challenging Popular Notions on Private Sector
Corruption

• Governance Corruption Measurement Useless?
• Evidence Has Corruption declined globally?
• Controlling of Corruption an outcome of
  development?
  
• Problem is solely with Public Sector/Officials in
  LDCs
  
• Public Sector sole shaper of the Investment
  Climate
  
• ACCs universal approach to private sector
  corruption?
  
• No Innovations in addressing private sector
  corruption
  
• Investigate Punish the only effective tool of
  A-C
  
• Corruption Cultural Historical Determinism

3
Tenet 10 Challenging the previous 9 popular
notions

• Data Matters -- on Governance Institutions
  data can be gathered, analyzed, used
  including by ACCs
  
• Corruption Matters US 1 trillion 300
  dividend
  
• Worldwide Corruption stagnation, yet variance
• Private Sector Corruption Underemphasized
• Private sector also an Investment Climate
  Maker
  
• Implications for institutions fighting corruption
  
  
• Innovations Transparency Incentives
• Data Partnership Illustration ICAC World
  Bank Mini-Survey
  

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Six Dimensions of Governance
Governance as the set of traditions and
institutions by which authority in a country is
exercised -- specifically

• The process by which those in authority are
  selected and replaced
  
• VOICE AND ACCOUNTABILITY
• POLITICAL STABILITY ABSENCE OF
  VIOLENCE/TERRORISM
  
• The capacity of government to formulate and
  implement policies
  
• GOVERNMENT EFFECTIVENESS
• REGULATORY QUALITY
• The respect of citizens and state for
  institutions that govern interactions among them
  
  
• RULE OF LAW
• CONTROL OF CORRUPTION

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Governance Data

• Data on governance from 37 different sources
  constructed by 31 different organizations
  
• Data sources include cross-country surveys of
  firms, commercial risk-rating agencies,
  think-tanks, government agencies, international
  organizations, etc.
• 352 proxies for all dimensions of governance
• Organize these measures into six clusters
  corresponding to definition of governance, for
  five periods 1996, 1998, 2000, 2002, 2004

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Control of Corruption one Aggregate Indicator
(selected countries from 204
worldwide, for illustration, based on 2004
research data)
Margins of Error
Good Governance
Governance Level
Poor Governance
Source for data 'Governance Matters IV
Governance Indicators for 1996-2004, D.
Kaufmann, A. Kraay and M. Mastruzzi,
(http//www.worldbank.org/wbi/governance/govdata/)
Colors are assigned according to the following
criteria Dark Red, bottom 10th percentile rank
Light Red between 10th and 25th Orange, betwee
n 25th and 50th Yellow, between 50th and 75th
Light Green between 75th and 90th Dark
Green above 90th.
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Control of Corruption, 2004 World Map
Source for data 'Governance Matters IV
Governance Indicators for 1996-2004, D.
Kaufmann, A. Kraay and M. Mastruzzi,
(http//www.worldbank.org/wbi/governance/govdata/)
Colors are assigned according to the following
criteria Dark Red, bottom 10th percentile rank
Light Red between 10th and 25th Orange, betwee
n 25th and 50th Yellow, between 50th and 75th
Light Green between 75th and 90th Dark
Green above 90th.
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Governance Matters The 300 Dividend

• Large Development Dividend of Good Governance
  a one-standard-deviation improvement in
  governance raise incomes per capita in a country
  by about 300 in long-run
• But is such a decline in corruption
  unrealistically large? NO -- One S.D. is the
  difference from Angola ? Brazil ? Estonia or
  Botswana ? US, Canada or Germany, or, the
  difference from Equatorial Guinea ? Cuba or
  Uganda ? Mauritius ? Portugal ? Finland or New
  Zealand
• 3. The impact is from governance to incomes, and
  not viceversa -- higher incomes alone will not do

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Development Dividend From Controlling Corruption
30,000
3,000
300
Data Source for calculations KK 2004. Y-axis
measures predicted GDP per capita on the basis of
Instrumental Variable (IV) results for each of
the 3 categories. Estimations based on various
authors studies, including Kaufmann and Kraay.
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Good Governance associated Countrys
Competitiveness
High
r 0.90
Low
Low
High
Sources GCI drawn from EOS firm survey, WEF 2005
117 countries Control of Corruption from
Kaufmann, Kraay and Mastruzzi, Governance
Matters IV Governance Indicators for 1996-2004.
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Measurable Worldwide Trends in Governance

• Through new method, we showed that it is possible
  to identify significant changes over time
  
• It is found that changes can take place in the
  short-term in 6-to-8 years, some deteriorations
  as well as some significant improvements as well
  
• Yet the world on average has not improved
• Good News Some countries are improving (while
  others deteriorate) in governance
  

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Significant Decline in Inflation Rates Worldwide
High Inflation
(avg. in logs)
Low
Source Rethinking Governance, based on
calculations from WDI. Y-axis measures the log
value of the average inflation for each region
across each period
13
Quality of Infrastructure
Source EOS 1997-2003 (Quasi-balanced panel).
Question 6.01 General infrastructure in your
country is among the best in the world?

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Judiciary Independence (EOS survey resuls
1998-2004)
High Independence
No Independence
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No Significant Trend in Control of Corruption
Worldwide Averages
Good
Poor
PRS country coverage in 1996 129, all other
periods 140 QLM and EIU country coverage 115
for all periods.
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Control of Corruption East Asia 2004 vs. 2000
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The Mezzo Level of Governance Measurement

• Based on cross-country surveys, mainly of
  enterprises (such as the EOS of WEF, BEEPS/WBES
  of WB, etc.)
  
• Thousands of firms interviewed on a range of
  issues focus on governance, specialized
  questions
  
• More detailed unbundling of governance and
  corruption phenomena than aggregate indicators
  
• Relatively broad country coverage, but less than
  aggregate governance indicators
  
• Measuring what is taking place De Facto matters
  it uncovers stark realities masked in De Jure
  indicators
  
• Addresses empirically It takes two to tango

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On Specifics the perspective of the firm

• Corruption is highly detrimental for the growth
  and competitiveness of a dynamic private sector
  
• It takes 2 to tango firms bribe, various
  patterns
  
• Unbundling Corruption different manifestations
• The behavior of some Powerful Firms and MNCs

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Top Constraints to Business vary across regions
(responses from the Firm in EOS 2005)
firms reporting constraint among top 3
Source EOS 2005. The question posed to the firm
was Select among the above 14 constraints the
five most problematic factors for doing business
in your country. Note that the overall EOS
sample covers 117 countries, and in some regions
particularly in the Middle East, Africa and the
FSU, many countries are not surveyed. Thus,
regional averages need to be interpreted with
caution, since typically countries not surveyed
tend to rate lower in governance than those
surveyed.
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Corporate Corruption, 2004
Firms report existence of bribery (avg across
types)
Source Authors calculations based on EOS 2004.
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Unbundling Corruption Different types of Bribery
(responses by firms 2005)
Firm Report High Bribery (1-3)
Bribery in
Source EOS firm survey, WEF2005 117
countries. Question In your industry, how
commonly firms make undocumented extra payments
or bribes connected with permits / utilities /
taxation / awarding of public contracts /
judiciary? (commonnever occurs).
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Multinationals Bribe Abroad? Firms Reporting
Frequent Procurement Bribery, EOS 2005
Source EOS, preliminary. Question In your
industry, how commonly would you estimate that
firms make undocumented extra payments or bribes
connected with the following permits, public
utilities, tax payments, loan applications,
awarding of public contracts, influencing of
laws, policies, regulations and decrees to favor
selected business interest, and judicial
decisions. Any firms reporting answers 1 through
3 were considered to be reporting at least high
frequency of bribery, while answers 4 through 7
were not.
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State Capture

• Firms shape the legal, policy and regulatory
  environment through illicit, non-transparent
  provision of private gains to public officials
  
• Examples include
• private purchase of legislative votes
• private purchase of executive decrees
• private purchase of court decisions
• illicit political party financing

Finding Countries subject to Capture of the
State (or Undue Influence) by powerful firms
exhibit much lower private sector growth than
countries that avoid State Capture
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Economic Cost of Capture for Growth
Based on survey of transition economies, 2000
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Addressing Capture Economic Reform, Political
Competition Voice/Civil Liberties Matter
Pace of Econ Reform
Political/Civil Liberties Reforms
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Stock Market Volatility vs. Control of Corruption
High
r -0.56
Low
Low
High
Sources KK 1998 and Morgan Stanley Capital
International Dataset and Emerging Markets
Database (1998). Stock volatility defined as the
standard deviation of monthly returns over
December 1984 to December 1998, multiplied by 100.
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Extent of Insider Trading vs. Control of
Corruption
High
r -0.55
Low
Low
High
Source EOS firm survey, WEF2003, and KK 2002.
Question to firms on insider trading Insider
trading is not common in domestic stock markets,
1strongly disagree, 7strongly agree.
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Stock Market Volatility vs. Extent of Insider
Trading
High
r 0.55
Low
Low
High
Sources EOS firm survey, WEF (1998) and Morgan
Stanley Capital International Dataset and
Emerging Markets Database (1998). Question for
insider trading Insider trading is not common
in domestic stock markets, 1strongly disagree,
7strongly agree. Stock volatility defined as the
standard deviation of monthly returns over
December 1984 to December 1998, multiplied by
100. Based on Du and Wei (2004)
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Insider Trading Significantly Affects Stock
Market Volatility An Example from Du and Wei
(2004)
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Findings on Governance Emerging Financial
Markets

• Du and Wei (2004) Insider trading higher
  market volatility
  
• Gelos and Wei (2005) find that in opaque
  countries
  
• FDI, herding intensity, , capital flight
  during a crisis
  
• Wei (2000) short term flows intensity in
  corrupt countries
  
• Mehrez and Kaufmann (1999) financial crisis more
  likely in less transparent countries
  (liberalizing)
  
• Acemoglu Johnson (2004) property rights
  institutions matter for growth, I, Financial
  Market Development
  
• Kaufmann, Mehrez Schmuckler (1999) Listening
  to data from firms matters for predicting crises

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Misgovernance Higher Fragility of
Financial Sector Soundness of Banks vs. Control
of Corruption(View of the firm, GCS 2001)
Low
Source Global Competitiveness Survey, 2001, KK
Governance Indicators
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General Implications -- departing from convention?

• Challenging popular tenets
• Governance measurement skepticism challenged
• Beyond corruption also governance
  transparency
  
• Not only administrative corruption -- influence
  peddling and state capture by firms is also key
  
• Private sector not merely the investment climate
  taker while public sector not alone as
  investment climate maker
  
• Governance Matters for country growth prospects,
  and for its financial markets
  
• Capital Market Development as Disciplining for
  Governance

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Towards Larger Role of Private Sector in
Anti-Corruption

• Address Undue Influence, Monopolies State
  Capture
  
• Data Power, Voice Freedom of the Press
• Transparency Reforms--substitute to
  over-regulating
  
• Engage Bussiness Associations Multinationals
• Money in Politics Political Campaign Finance
  Reform
  
• Focus on Incentives Prevention raising the
  cost
  
• Corporate Social Responsibility reconsidered
• Capital Markets Development as
  market-disciplining
  
• Addressing Financial/Banking sector challenges
• ACCs, IFIs To do more in engaging the Private
  Sector

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Specific Innovations, Initiatives, ACCs

• Data Indicators on private sector corruption
• Public Delisting of Companies engaged in
  corruption
  
• Voluntary Disclosure Programs (VDPs)
• Outreach on Transparency/Integrity Standards for
  Firms
  
• Need to strengthen ACCs to fulfill its role
• -- Independence from Political Interference
• -- Political Commitment to Independence,
  Resources
  
• -- Strengthen Investigative function
• -- Outreach, Incentives-Based Prevention
• --Advocacy for key Reforms
• -- Legitimacy in the eyes of the corporates
  citizens
  
• onto Survey

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10 Transparency Reform Components for a Scorecard

• Public Disclosure of Assets Incomes of
  Candidates, Public Officials, Politicians,
  Legislators - dependents
  
• Public Disclosure of Political Campaign
  contributions by individuals and firms, and of
  campaign expenditures
  
• Public Disclosure of Parliamentary Votes, w/out
  exceptions
  
• Effective Implementation of Conflict of Interest
  Laws, separating business, politics, legislation,
  government
  
• Publicly blacklisting firms bribing in public
  procurement
  
• Effective Implementation of Freedom of
  Information Law, with easy access to all to
  government information
  
• Fiscal/Financial transparency central/local
  budgets EITI
  
• Eprocurement transparency (web) and
  competition
  
• Transparent, Streamlined Regulatory Framework-
  0-based
  
• Corruption Diagnostic Surveys, Governance
  Monitoring-- Data

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Data for Analysis and Informing Policy Advice,
Not for Precise Rankings

• Any data on Governance, Institutions, and
  Investment Climate is subject to a margin of
  error. It is not intended for precise country
  rankings, but to highlight relative strengths and
  weaknesses and draw analytical and policy
  lessons. The data and indicators do not
  necessarily reflect official views on rankings by
  the World Bank or its Board of Directors. Errors
  are responsibility of the authors.
• Further materials access to interactive data
  
  
• General www.worldbank.org/wbi/governance
• Data www.worldbank.org/wbi/governance/govdata/
• Governance Matters IV Report and Materials
  www.worldbank.org/wbi/governance/pubs/govmatters4.
  html
  
• Synthesis Article about Myths on Governance in
  FD http//www.imf.org/pubs/ft/fandd/2005/09/basi
  cs.htm